The Impact of House Prices on Inflation Expectations and Monetary Policy

Vedanta Dhamija, Ricardo Nunes, and Roshni Tara

In recent years, inflation has become a focal point of economic discussion, extending beyond just grocery prices and utility bills. Our analysis, outlined in Dhamija et al (2026), indicates that house prices play a significant role in shaping these inflation perceptions. Households in the United States seem to assign a weight of 25% to 45% to house price expectations when assessing inflation, which is notably higher than the actual representation of housing costs in the Consumer Price Index (CPI). This raises the important question: should central banks be concerned about this discrepancy? The answer is affirmative.

Understanding the Role of Expectations

Expectations around inflation are vital as they directly influence economic behavior. When households anticipate rising prices, they often modify spending and savings habits, along with wage increase demands, which can perpetuate inflation. Central banks monitor inflation expectations closely, making it crucial to understand how these perceptions form.

Household inflation expectations are influenced by a variety of factors, including prior beliefs, media exposure, monetary policy knowledge, cognitive abilities, and shopping experiences (Coibion et al (2020)). More than just frequent price changes, prominent price dynamics—such as significant shifts in housing costs—strongly affect these expectations.

Housing is commonly recognized as the largest financial asset for most households, influencing overall wealth and borrowing capacity. Furthermore, housing expenses constitute the largest segment of household budgets for both renters and homeowners. Fluctuations in housing prices receive considerable media coverage and are central to discussions on affordability and living standards, particularly in a country like the US, where a large portion of the population are homeowners.

The Exclusion of House Prices from Headline Inflation Measures

Despite the significance of housing, house prices are not included directly in headline inflation metrics. The CPI captures housing services via the Shelter component, which comprises around one-third of the overall index. Within this measure, the Owners’ Equivalent Rent (OER) is a crucial metric, derived from regional rent surveys and adjusted for homeowner proportions. This approach reflects the market value of rents, emphasizing the consumption aspect rather than treating housing as an asset.

Chart 1: House Price Growth and CPI Shelter Inflation

This chart illustrates the growth of CPI shelter inflation alongside the S&P/Case-Shiller US national home price index from 1987 to 2022. The data highlights that while house prices have experienced significant volatility, the OER and other components of shelter inflation have remained relatively stable, indicating that these indirect channels influence the overall inflation index minimally.

Our analysis establishes an ‘accounting benchmark’ to quantify how house price fluctuations should theoretically impact CPI inflation. By examining US data from 1987 to 2022 and regressing actual house price growth against overall CPI along with its key components, we find an implied elasticity between 0.004 and 0.04. This suggests that a one-percentage-point rise in house price inflation might increase CPI inflation by no more than 0.04 percentage points, indicating that households likely overvalue house price changes when considering overall inflation.

Household Perception of Housing Assets vs. Services

Using the Michigan Survey of Consumers (MSC) and the Survey of Consumer Expectations (SCE) conducted by the Federal Reserve Bank of New York, we analyzed household behaviors in the U.S. These surveys allowed us to understand the correlation between household inflation expectations and their expectations regarding house prices. By controlling for variables such as demographics, geographic region, and historical price growth, we aimed to mitigate potential endogeneity issues.

The results reveal that a one-percentage-point rise in expected house price growth correlates with a 0.25 to 0.45-percentage-point increase in inflation expectations. Such findings indicate a significant weight that households assign to housing price changes in their inflation assessments.

Assessing the Impact on Monetary Policy

To determine the implications of such household behavior for monetary policy, we incorporated these findings into a two-sector New Keynesian model. This model suggests that households disproportionately focus on inflation in one sector relative to its actual economic weight, potentially skewing their inflation perceptions. Previous studies, including those by D’Acunto et al (2021) and Coibion and Gorodnichenko (2015), have similarly noted a tendency for households to overweight essential goods, such as groceries and fuel, in their inflation expectations.

This skew in expectations has downstream effects, distorting household decisions regarding consumption and savings, and creating discrepancies between perceived and actual inflation rates. Notably, while this mismatch does not alter firms’ price-setting behavior, it complicates the overall economic landscape. Our findings suggest that central banks should adjust nominal interest rates in alignment with perceived inflation expectations to mitigate any distortions caused by this overweighting.

Chart 2: Optimal Response to a Markup Shock in Models

This chart illustrates how a central bank should respond to inflation due to a markup shock in an overweighted sector. An increase in profit margins drives inflation higher. Given that households overly emphasize changes in this sector's prices, their inflation expectations rise more sharply than usual. To stabilize overall inflation, central banks must raise their policy rates more than they otherwise would, aligning the economy with trajectories comparable to those without such distortions.

Conclusion and Policy Considerations

Research has shown that individuals have a tendency to weight frequently observed prices heavily in their perception of inflation expectations, with house prices emerging as a significant influence. In Dhamija et al (2026), we have identified a critical channel through which house price expectations impact inflation thinking.

There are two primary implications for monetary policy: first, central banks should closely monitor the housing sector due to its pronounced impact; second, understanding this household bias is crucial for determining how inflation expectations evolve. The knowledge that households emphasize price movements in salient sectors, like housing, indicates that central banks need to respond more vigorously to inflation shocks in these areas.

Going forward, we intend to explore the role of house price expectations in forming inflation perceptions in the UK and other countries, potentially uncovering further insights into central banking strategies.

Vedanta Dhamija works in the Bank’s Monetary Policy Strategy Division, Ricardo Nunes is a Professor of Economics at the University of Surrey, and Roshni Tara works in the Bank’s Economic Outlook Division.